Lee Sharpe looks at a scenario where a director might want to trigger the company’s PAYE liability earlier than usual.
Many readers will be aware that there are special rules setting out when an employee is deemed to be paid, for tax purposes. In essence, the legislation seeks to ensure that pay as you earn (PAYE) is applied as soon as is reasonably possible (or, from HMRC’s perspective, to ensure that PAYE is applicable as soon as the employee is able to benefit from his or her salary).
In a recent article, we looked at how to make sure that the employing business or company gets tax relief for a bonus or similar provision. In this article, we look at how the rules may be applied potentially to benefit a director.
Review of the rules
The rules for general earnings such as a bonus or salary, and when they are deemed to be paid, are set out in the tax legislation (at ITEPA 2003, s 18) (please see HMRC’s Employment Income manual at EIM42260 and subsequent pages for details of HMRC’s position on how the rules work). For ordinary employees, it is the earlier of:
- when a payment of earnings is actually made, or when a payment on account of earnings is made; or
- the time when a person becomes entitled to payment of earnings, or a payment on account of earnings.
So, even if payment is not made, PAYE can be applied once an employee is entitled to be paid.
The rules for directors are more complex. HMRC would argue that this is because directors have more say in how payments can be made, so other, more unusual arrangements need to be considered. For directors, it is the earliest of:
- when a payment of earnings is actually made, or when a payment on account of earnings is made (as above);
- the time when a person becomes entitled to payment of earnings, or a payment on account of earnings (as above); plus
- the date when earnings are credited in the company’s accounts or records;
- where the amount of the earnings is determined before the end of the period to which they relate, the date that period ends; or
- where the amount of the earnings is determined after the end of the period to which they relate, the date the amount is determined.
Contingent events
It is very common for a business to make provision in its accounts for expected future liabilities. A simple example would be to provide for the heat and light that a business uses, even if it may not be billed until several months later. This is called an accrual, and it is allowable for tax purposes. More precisely, it could be argued that the obligation to pay arises immediately that the electricity is used, without having to wait for an invoice; a possible future obligation could be a claim under warranty, or an agreement that a bonus will be paid based on the happening of a future event.
Such provisions are common and, as we have seen in a previous article, it is possible to ensure that the employing business gets a tax reduction but that the obligation to account for PAYE is triggered later, when the event itself occurs.
But what if you want the payment to be triggered earlier?
Example - Deliberately triggering early payment
John is a director of a small company. The business is profitable but has poor cashflow because it depends on a few large contractors in the construction industry. The board has set salaries and a bonus for John, based on the company’s profits for the year, which are very good. However, the bonus will be paid only when a particularly large sales invoice is settled to a satisfactory extent/percentage. As the timing is uncertain and based on a future event, PAYE is not due immediately but when the criteria are met. John has also made a personal pension contribution to ensure that the bonus doesn’t take him into an even higher tax band.
As the end of the tax year draws near, the debtor company still hasn’t paid. Although he is confident that the debtor company will pay, John is worried that his bonus will not be paid until just after the end of the tax year, and his careful personal tax planning may be undone. He turns to the company’s tax adviser for help.
John explains to the adviser that the company is prepared to pay the PAYE before the sales invoice is settled but he understands that the company does not have the cash funds to pay John his net bonus as well. John is confident that the debtor will pay soon but not before the end of the tax year.
Triggering the bonus
Considering the above ‘triggers’ for when earnings are deemed to be paid, it is possible to bring forwards the payment date for tax purposes, so that John’s personal tax planning is saved. The company’s tax adviser recommends that the bonus be credited in John’s favour, in the company’s books and records. It is not necessary for the cash physically to be paid to John: the net bonus can be set against John’s director’s loan account, or a separate account set up in the company’s ledgers.
Once the company has ensured that the amount has been credited in the business accounts, as earnings, John will be deemed to have been received payment; PAYE will be due and he will be taxed on that bonus in the tax year he that he planned for.
A word of warning; the adjustment effectively changes the board’s original decision to withhold the bonus payment until the customer had paid. This change in plans is not wrong, but must be ratified and minuted/recorded accordingly.
Practical Tip:
It is relatively unusual for a company or its employees to want to have income taxed ‘early’; but when they do, HMRC is only too happy to lend a hand! More generally, it is often useful to credit a director’s account with the company for him or her to draw down funds as and when required, rather than simply pay the money out in cash immediately, because it helps to keep a loan account in credit for longer. The rules around ‘earnings’ can become quite complex and, where the amounts involved are significant, it is important to take proper advice to ensure that the rules work as intended.
